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Today I will tackle a question that I’m regularly asked: How do decide if I’m getting enough yield on any given bond? Put another way, how do I find value?

As you might expect, I wrestle with this question every day. What’s critical for investors to realize is they can’t know if they’re finding value or not just by looking at the coupon (bond speak for the interest rate).

The coupon is the starting point for deeper analysis. To determine actual value, you need to put the bond’s coupon and yield in context. For example, how does the interest rate compare to other benchmarks? What are the recent and historical price trends between these benchmarks?

In the end, great analysis does more than simply divide the universe of bonds into good and bad credits; it’s nuanced enough to identify credits that are too expensive, and credits that are bargains. As investors, you need to keep an open mind, challenge preconceptions and be brave enough—and I choose this word on purpose—to follow the analysis where it leads you.

To illustrate the twists and turns on the way to finding—and not finding—value, let me recount a recent real-life example.

In August I began analyzing the $118 million Sam Rayburn Municipal Power Agency Power Supply Revenue Refunding bonds [NR/BBB+]. North of Houston, TX, the utility is a power transmitter (as opposed to a generator) to the cities of Livingston, Liberty and Jasper. The investment banking firm underwriting the bonds structured the issue with serial maturities from 2013 to 2021. The initial price thinking for the 2021 maturity was a 5% coupon to yield 3.20%.

Sam Rayburn’s triple-B-plus rating put it on the lowest investment grade rung. Given the rating, some investors might assume Sam Rayburn is a lower-quality credit. But they would be wrong.

The TIAA-CREF Municipal Bond Team examined the security for the bond as well as the economic and financial condition of the borrower and determined that Sam Rayburn was a stable credit that simply did not need to maintain a higher rating. This did not come as a surprise to me.

A little-advertised fact in the municipal bond market is that not every borrower needs or wants a triple-A rating. In Sam Rayburn’s case, a higher rating would require significantly higher margins and cash balances, which would probably lead to higher rates for customers. That would run counter to its mission of providing affordable power at reasonable rates.

What’s more, Sam Rayburn only occasionally taps the capital markets because its capital needs are fairly low, so the cost savings of maintaining a triple-A rating would be tiny and not worthwhile.

Having identified Sam Rayburn as a strong triple B credit, I next turned to the question of pricing. Was the 3.20% yield a good offer? Like other professional municipal bond investors, I use the Thomson Reuters Municipal Market Monitor (MMD) as a benchmark to make these kinds of assessments. The MMD is a series of market-based yield curves, from one-to-thirty years for triple-A to triple-B credits in different sectors (i.e., general obligation, hospital, electric power).

When measuring relative value, investors subtract the proposed yield on a bond from the corresponding yield on the MMD. The bigger this difference or “spread,” the more likely you’re staring at a bargain.

In this case, I looked at the MMD A Electric Power as a benchmark, since there is no MMD for BBB-rated bonds in the electric power sector. I saw that the difference between the yield on the MMD A Electric Power (2.45%) and the Sam Rayburn offering (3.20%) was 75 basis points (a basis point is one-hundredth of a percent).

That seemed like it could possibly be a good value. But, alas, I wasn't the only investor doing my homework. At that spread, investor interest was intense. The underwriter calculated that the bonds would be nearly 25 times oversubscribed (i.e., 25 buyers for every one bond). That kind of demand is a happy problem for the underwriter, who can command a lower interest rate for the client—and that is exactly what happened.

The underwriter formally priced the 2021 bonds at 3.02%, nearly 20 basis points less (bps). Investor interest remained strong, however, and was still 10-times oversubscribed. In response, the underwriter lowered the yield again, with the final price settling at 2.87%.

In the end, the bond’s spread with the MMD Electric Power A benchmark had “tightened” to a much less generous 48 bps. Clearly the offering was less attractive, but was it still worth buying?

To help answer this question, I analyzed industry spreads and price trends to put the Sam Rayburn bond in context. Was 2.87% still a bargain compared to historical prices in the industry or had the tightening made the offer too expensive?

To me, the answer was pretty unequivocal. Another spread relationship I examine is the “credit spread”—the difference between the yield on a triple-A credit and credit with a lower rating at the same point on the yield curve. Credit spreads were very tight on a historical basis. From January until the day the bonds were formally priced in August, the spread between the MMD AAA and the MMD A Electric Power tightened steadily from 90 bps to 69 bps.

Worse for this particular deal, however, was my conclusion that spreads really couldn’t tighten much more, which means we would be buying near the top of the market.